- The Washington Times - Thursday, May 27, 2004

Q:I would like to ask your advice on five-year, three-year, and monthly adjustable-rate mortgages. I have owned a property in Stafford County for the past 10 months. I have a 6.5 percent 30-year fixed-rate mortgage.

My principal-and-interest payment is $1,540, and my mortgage balance is about $245,000.

I am in the military and know that I will have to move in three years. Your columns about ARMs struck my interest. Do you think I should refinance to an ARM to lower my rate? I am especially interested in the monthly ARM.

A: As I’ve mentioned before, taking out a fixed-rate mortgage is akin to buying an insurance policy. In exchange for a higher rate, you are shielded from any future interest-rate fluctuations.

If you are relatively certain you will be selling your home in three years, taking out a 30-year fixed-rate mortgage is the same as purchasing an insurance policy that you know you’ll never use. I think you are correct in questioning whether your current mortgage program is optimal for your objectives.

Let’s look at a few market rates.

A 5/1 ARM carries a fixed rate for the first five years and adjusts annually thereafter, thus the name 5/1.

If you sell within three years, a 5/1 ARM will certainly see you through and give you two years to spare, in case the military keeps you in the area.

I see that the current interest rate with zero points and zero closing costs is 5.625 percent. The principal-and-interest payment on a loan amount of $245,000 is $1,410 — a savings of $130 per month for you.

Over three years, you would save $4,680. If you were to hold the loan for five years, you would save $7,800.

This option is clearly a “no-brainer” as long as you pay off the loan within five years, as you intend to.

Before I go on, I need to mention that the interest rates I’m quoting carry no fees whatsoever and are as of the time of writing this column.

Anyone planning on holding a loan for a short period must keep the transactional closing costs to a minimum, preferably zero.

In exchange for a low- or no-closing-cost loan, you will be paying a higher rate.

The problem with loans with substantial nonrefundable fees is that you cannot recoup the costs in the form of a lower rate within the time that you’ll hold the loan.

To put it bluntly, don’t be swayed by a seemingly low note rate that carries thousands of dollarsin closing costs.

Now, let’s look at a 3/1 ARM, which is fixed for the first three years.

I see that the zero-cost rate drops to 5.125 percent, creating a P&I; payment of $1,334. This program would save you $206 per month, or $7,416 over three years.

The monthly ARM is super-cheap. I doubt you’ll be able to find a no-closing-cost rate for this program, but since the rate is so low, it might be something to consider.

A fully indexed monthly ARM tied to the London Interbank Offering Rate is hovering at about 3.125 percent.

The closing costs in Virginia will be somewhere in the neighborhood of $2,300.

The P&I; payment drops to a rock-bottom $1,049 per month, a difference of $491 from your current payment.

Deciding whether this program is best takes a little more thought.

First, you have to fork out $2,300 in cash or add $2,300 to your loan balance. Either way, the loan will cost you $2,300.

Second, you have to realize that this rate can change monthly. If the rate remains stable, you recoup the closing costs in less than five months ($2,300 divided by $491).

If the rate stays low for the next three years, you’ve hit a home run. That $491 you save per month adds up to $17,676 over three years. Subtract the $2,300 in closing costs, and you have a net savings of $15,376.

The problem is that this rate will not remain stable. In fact, all indicators point to higher rates. So the question becomes “How high and when?” Historically, the LIBOR is slow-moving, which is a good thing if it’s rising.

A good loan officer will be able to discuss this program in detail so you can determine whether a low-rate monthly ARM is right for you.

At the very least, I would certainly recommend that you investigate a zero-cost 5/1 or 3/1 ARM.

There’s no need to pay for an insurance policy that won’t be used.

Henry Savage is president of PMC Mortgage in Alexandria. Contact him by e-mail (henrysavage@pmcmortgage.com).

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